Dear College Money Guru,
My son starts college next year. His 529 is worth less than the amount of money we contributed over the last six or so years. Is Congress looking at this scenario (as they have with retirement distributions)?
— Martha Nelson
In the aftermath of the 2008 stock market collapse, Congress passed a law waiving the requirement, for 2009 only, that individuals age 70 1/2 and over take minimum annual distributions from their IRAs, 401(k)s and other qualified retirement accounts. Our elected representatives in Washington felt it would be wrong to force retirees to liquidate their investments while market values are down so substantially.
However, Congress has not made any such changes affecting 529 plans. Unlike qualified retirement accounts, 529 plans are not subject to required minimum distributions. You can continue to keep your 529 account intact for as long as you have a living individual named as beneficiary. The fact that you can change beneficiaries to another qualified family member, including descendents, at any time means that your account can stay invested for many, many years without being distributed.
However, in your particular situation, the money in your 529 account may be needed fairly soon to pay your son’s college bills. The tax-free feature of 529 plans will be of no use to you if your account has no net earnings. You may want to delay using your 529 plan for as long as possible to give it a chance to rebound in value.
Perhaps you can target the use of the 529 money to your son’s junior and senior years in college and take loans or use other money in the meantime. Just make sure you do not wait so long that the remaining college expenses are less than your 529 account balance. To be tax-free, your 529 distributions should not exceed the amount of qualified expenses paid in the same year.
Another option is for you to liquidate the account and distribute the entire balance back to yourself. By doing so, you are able to claim the loss as a miscellaneous, itemized deduction on your federal tax return. You’ll receive a tax benefit to the extent your total miscellaneous itemized deductions exceed 2 percent of your adjusted gross income and provided you itemize your deductions and do not fall into the alternative minimum tax. Because there are no earnings, there is no 10 percent penalty to worry about, regardless of how you spend the proceeds. You should speak with your tax professional before making this decision, and be sure to ask about any potential state income tax consequences.
While Congress has made no changes affecting 529 plans in the current market environment, the Internal Revenue Service has offered a little more flexibility. For 2009 only, you will be permitted to make up to two investment changes in your 529 account. Previously, you were restricted to one change in any calendar year, although you can change investments any time you change beneficiaries.